FHA insurance premium hikes will impact high wage earners most

Housing markets in Coastal California are dominated by high wage earners. In the more affluent markets, the GSE conforming loan limit is $625,000, yet the FHA limit is $729,750. GSE conforming loans can be obtained with only 5% down with private mortgage insurance of around 0.62%. FHA loans previously could be obtained with 3.5% down with an PHA insurance premium of 1.25%. The FHA loan which only requires 3.5% down instead of 5% has been very popular despite the onerous insurance premiums because after a massive debt binge and severe recession, most potential homebuyers are still broke.

The loan limits create large breakpoints where borrower costs escalate rather dramatically. Borrowing more than $625,000, the GSE loan limit, requires FHA insurance. At 1.25%, the cost is greater than property taxes here in California. Borrowing more than $729,750 requires 20% down and a higher interest rate. The 20% down requirement eliminates nearly all first-time buyers.

So where does that leave us? The first-time market is limited by the $729,750 FHA loan limit, and costs escalate quickly when loans exceed $625,000. Adding in a 3.5% or 5% down payment creates affordability cutoffs at $660,000 and $750,000. That’s why the market below $660,000 is so active while the market over $750,000 survives based on squatting (See: The move-up market will suffer for another decade). The transition zone between $660,000 and $750,000 is about to become more expensive and harder to penetrate. This will likely slow sales at these price points, and it may cause prices to weaken.

FHA to hike premiums on mortgages

By Les Christie @CNNMoney January 31, 2013: 2:10 PM ET

The Federal Housing Administration is raising premiums and taking other measures in order to bolster its capital reserves and reduce its exposure to risky loans.


Government-insured mortgages are about to get more expensive.

The Federal Housing Administration, which is the largest insurer of low-down payment mortgages, announced Wednesday that it will raise premiums by 10 basis points, or 0.1%, on most of the new mortgages it insures.

Translation: A borrower opting for a 30-year, fixed-rate mortgage who puts 5% or more down will now pay an annual insurance premium of 1.3% of their outstanding balance. And someone who puts less than 5% down will pay a premium of 1.35%.

The agency said it will also raise premiums for borrowers with jumbo loans — or loans of $625,000 or more — by 5 basis points, or 0.05%, and increase the minimum down payment requirement on these loans to 5% from 3.5%.

The increase costs are noticable, but it’s the increase in down payments that will cause the most problems. The mandatory 5% down on loans between $625,000 and $729,750 will be a problem. Some will argue that another $10,000 down for a high wage earner shouldn’t be a problem, but in reality, it is. How much longer will borrowers have to save to scrape together another $10,000? Remember, these are first-time buyers mostly with high wages, but also large student loans, leased cars, credit cards, and expensive tastes. Even the austerity of $1,000 a month will delay many purchases for up to a year.

FHA said it will require most buyers to pay insurance premiums for the life of their loan. A policy that was put in place in 2001 allowed borrowers to cancel premium payments once their debt fell below 78% of the principal balance. One exception will be for borrowers who put more than 10% down at the time of purchase.

This is a deal-killer for me. We are at record low interest rates, so in all likelihood, mortgage rates will go higher from here. Although it may be possible to refinance later to eliminate the insurance premium, it may not be advantageous if refinancing carries a much higher interest rate. It’s very possible some of these borrowers may be paying that onerous FHA insurance premium for as long as they own their properties or up to 30 years.

I believe this will concentrate buying pressure in the $660,000 to $680,000 price range. Borrowers won’t want to go higher and use the FHA loan due to the high insurance rates, and most borrowers won’t have the savings to push much higher than that. Above $680,000, I believe the first-time buyer interest will dissipate considerably.

Additional new policies include a requirement that any mortgage for an applicant with less than a 620 credit score and debt-to-income ratio above 43% must be underwritten manually. Lenders who want to issue loans to these applicants must be able to adequately document why they decided to approve the loans.

In other words, “Lenders, don’t underwrite those loans.” Lenders who stray from those guidelines can expect buybacks when the loans go bad.

The agency also decided to put new restrictions on reverse mortgages, no longer permitting retirees to take such large, upfront payments.

Good. I think reverse mortgages are the worst financial instrument ever created. They are a financial cancer peddled to old people who don’t know any better.

Related: Where are the first-time homebuyers?

The changes are an effort to reduce the agency’s exposure to risky loans and bolster its financial reserves, which have been depleted due to high delinquency rates from the mortgage crisis. The agency did not say when the new rates will take effect.

Last spring, FHA increased both premiums and upfront costs on mortgages. Such hikes make it tougher for mortgage borrowers — especially first-time purchasers who can’t afford the large down payments most private lenders require today, according to Jaret Seiberg, a Washington policy analyst for Guggenheim Partners. “They are the ones most likely to turn to the FHA for credit,” he said.

And that could have a negative impact on the housing market overall. “You can’t have a healthy housing market without a constant influx of first-time buyers,” said Seiberg.

It will cause a weakening of sales and perhaps lower prices. Whether or not that’s a negative impact depends on your point of view. Less indebted borrowers with greater capacity to repay their loans is a good thing even if it means prices must be lower to accommodate.

Higher costs on government loans is a good thing

Taking a broader view of the situation, these increasing costs on government-backed loans are a good thing. Ultimately, we don’t want the government to back 95% of the loans in the housing market. The best way to reduce the government’s footprint is to increase the costs on these loans so that private lenders will find opportunities. For example, some time back I reported that FHA = subprime, 12.4% interest cost of FHA insurance, 50% risk premium. The cost of FHA insurance was akin to taking on a 12.4% second mortgage. As these premiums go up, so does the effective interest rate. Eventually, the cost will be so high that some lender will offer a second mortgage at 12% and make a profit. All the loan programs offered by the government could be replaced with private lending, and if politicians keep jacking up the fees, private money will find niches where it can return. In the end, that’s what we all want because without private lending, taxpayers will absorb the losses if markets become unstable again. We’ve paid enough this time around, so I’d rather not be on the hook for the next one.